It's exciting to get a raise, especially if it's bigger than you expected. That's why it's understandable and common that in the afterglow, many people rationalize an immediate increase in spending. Perhaps you've been waiting to purchase a new vehicle, have your eyes on a nicer place to stay, or just want to take a few more vacations. There's nothing wrong with financial goals, but all too often, a modest pay increase gives us a false sense of security in overextending our finances. Before we realize it, we've already more than accounted for our increase in income, and besides a few new gadgets or perks that quickly lose their novelty, we're no better off than we were before. This is what many term "lifestyle inflation," and if you want to increase your net worth, it's a pitfall to avoid.
1. Give your cheque a reality check
The problem with lifestyle inflation starts with the reality that the average pay raise is about 3% a year. When you factor in taxes, inflation and increasing costs of living, it's not as much as it looks like on paper. An easy way to calculate your actual after-tax (and other adjustments) raise is to punch the numbers in an online “take-home pay” calculator. The amount of usable income you're gaining may be surprisingly lower than you thought. With a realistic figure, you'll make more informed choices about which, if any, lifestyle upgrades you can afford.
2. Sit on it
Is it really necessary to immediately allocate the increase in take-home pay? Are there any negative consequences if you don't? Absolutely not. After all, you were most likely living just fine before you got that raise. Unless you have pressing needs, the wisest course of action is to sit on that extra cash for a while. Let a few months go by so you can get a feel for your new financial situation and carefully consider all your options. Waiting will often cool the impulse for extra spending and clarify what, if any, upgrades are necessary and beneficial. Seeing your funds accumulate is also a rewarding experience.
3. Increase your savings
One of the first things you should do with your raise is increase your savings. If your plan is to set aside a certain percentage of your income, that dollar amount should obviously increase as your income increases. For those who make automatic transfers to savings and investments accounts, don't forget to adjust the amount that gets moved. As your savings grow, consider diversifying into various types of investments. While you weigh your options, put it to work in a high-yield savings account. Saving money is said to be a way of paying yourself, and in the long run, that's very true.
A study by Payscale indicates women's wages max out at age 39, and men's at 48. This means statistically, saving early is a must because you can't expect salary increases to keep bailing you out, as you may not continually earn more as you age.
4. Treat yourself, but sparingly
You've worked hard for your raise and you deserve to spend a little of it as you please. Limit this to a one-time item/event, though. You can also modestly increase the “fun money” allowance in your budget but avoid adding long-term expenses. This goes back to the first point of understanding exactly how much your net income has increased and making your decisions accordingly.
Make a point to follow these tips and avoid the lifestyle inflation cycle the next time you get a raise.
This article was written by Jessica Sommerfield from MoneyNing and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to email@example.com.